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The FIA industry is a consumer driven industry that has had financial advisers in a constant search of the most efficient way to satisfy the growing class of risk‐adverse clients on their way to retirement. The analysis included below examines several types of FIA products and aims to illustrate what advisers need to be considering when recommending FIAs to their clients.

The fixed indexed annuity has made tremendous progress in product development since its introduction in the mid‐90s due to an increasing desire for principal protected investment products. The FIA industry is a consumer driven industry that has had financial advisers in a constant search of the most efficient way to satisfy the growing class of risk‐adverse clients on their way to retirement. The risk adverse demographic is growing at an incredible rate due not only to the boomer generation, but also due to the market collapses of the last decade infecting portfolios of all investor classes.

Naturally, the shock of portfolio devastation lead many clients into confusion and timidity about jumping back into investments with underlying risk. Principal preservation very quickly became a priority, especially for those whose retirement could not afford further losses. The increase in interest favoring safer investment vehicles is evident by the increase in FIA sales from 2000 at 5.25 billion to 26.7 billion by 2008 (Koco, 2009)i. This 508 percent increase illustrates a shift in consumer behavior toward their investments while at the same time serving as an alarm of opportunity for FIA providers to accommodate this paradigm shift. Insurance companies began to realize that within the financial services industry, consumers were beginning to share a larger interest in lower risk investment products. This opened a new financial market, and the competitive FIA market took off.

A rule most people tend to agree upon is that competition ultimately benefits the consumer. The FIA market was and still is no exception. Because of the competitive nature of the financial services industry, and the importance it plays in everyone’s life on a daily basis, the FIA has, at the good fortune of the client consumers, experienced tremendous improvement since its introduction, and the products being recommended now are arguably the most competitive to date. The big question, however, is which
products are you recommending?

The analysis included below examines several types of FIA products and aims to illustrate what advisers need to be considering when recommending FIAs to their clients.

Bonus versus non bonus annuities

It is no secret that a majority of all annuity products sold in the industry have a bonus. The idea of a bonus is exciting and romanticized as if the client has won a prize, and because of this excitement, it is easy to understand why it is the most popular type of annuity sold. The fact is, however, bonus products have utility in far fewer situations than most advisers realize. In my opinion, bonus annuities should be used in the following situations as a rule: a client needs to overcome a surrender penalty and/or a client is in relatively poor health and longevity presents a concern1.
Bonuses are great for maximizing value in short-term situations, but over time, most non bonus annuities outperform most bonus products. Again, as a rule of thumb, bonus annuities provide lower caps and rates compared to non bonus products.

Consider the following: An average commission in the industry is just below 7 percent, add a bonus of 10 percent paid to a client, and the carrier is on the hook for 17 percent out of the gate. Because annuity carriers are not simply giving money away, they need to bring down their exposure by limiting the gains the client can receive over the contract term in order to recoup the initial 10 percent bonus paid to the client. A 5.25 percent cap vs. 4.00 percent may seem negligible, but over time, the additional 1.25 percent at a compounded rate can result in significance disparity between account values. See example Figure 1.0 below:

Sample Historical Performance (2/28/1991 - 2/28/2011)

Figure 1.0ii

Figure 1.0 illustrates a 20 year indexed annuity with a 10 percent bonus and a 4 percent annual point to point cap compared against two separate 10 year indexed annuities without bonuses and annual point‐to‐point cap rates at 5.50 percent and 6.25 percent.
For roughly the first six years of the contract, the clients is ahead with the big bonus but is ultimately eclipsed by the higher rates of the other two annuities in the seventh year. This is a very common occurrence in annuity comparative analysis and should be carefully considered when recommending products to clients. Clients are enticed by the big bonus because of the immediate satisfaction of instantly increasing their investment’s value, which is understandable. However, assuming the client is investing for growth, the client would be better served by examining the numbers. See Figure 2.0 below for the annualized returns and hard numbers comparing the same three products:

Figure 2.0iii

Figure 2.0 illustrates the same 20 year period in the S&P 500 from dates February 28th, 1991 through February 28th 2011.

The data displayed in both Figure 1.0 and Figure 2.0 clearly demonstrates the advantage of higher rate products without bonuses versus lower rate products with bonuses. Bonus annuities certainly have their place in this industry, but as empirical data shows, a bonus annuity may not always be the best product for your client.

Rates versus strategies

“Growth with no risk” is a pretty accurate answer you are likely to receive when you ask a FIA client or FIA adviser why they prefer their FIA over other investment alternatives. It is rarely ever put in simpler words, and at the same time is a perfect way to describe FIAs (there are additional reasons clients purchase fixed products as each client potentially presents a unique situation, and we will discuss those in a forthcoming article). FIAs come in various term lengths and for the most part are all very
similar investment vehicles for growth. Aside from additional riders as differentiating factors, an extremely important feature to consider when reviewing FIAs is their many different indexed strategies.
This is also one of the most overlooked features in the FIA market during low interest rate environments and harsh economic times like we have experienced over the past two years2.

Naturally, the rates of FIA products control the interest credited toward client policies. Therefore, when rates begin dropping, the search for the highest rates begins. Unfortunately, the association of higher rates with growth, though understandable, is fallible3. It is imperative that advisers understand that even though rates control interest credits, it is the strategies of the indexing methods that provide value to the underlying rates. It is very important to understand index strategies, and perhaps even more important, is understanding which strategies to employ in various market environments. Each index strategy has its place in certain market conditions, and with a dynamic market, FIAs with multiple strategies present better opportunities for growth4. See Figure 3.0iv

Figure 3.0iv

Figure 3.0 illustrates a 10 year period, February 28, 2001 through February 28, 2011, using three different crediting strategies indexed to the S&P 500. The illustrated strategies are the annual point–to‐point, monthly point‐to‐point, and monthly average with participation rate and a 1.50 percent spread. The highlighted numbers exhibit the best performing strategy for its respective year.

Figure 3.0 shows multiple strategies with their respective rates over a 10 year time period. The annual point‐to‐point (APP) and the monthly average (MoAVG) are illustrated with high rates relative to today’s current interest rate environment while the monthly point‐to‐point (MPP) is shown with a cap adapted to current rates available today. If the client was advised to purchase a FIA with all three strategies, then the potential for higher returns greatly improves. If the client simply diversified amongst all three, the blended yield would be much higher than if the client stuck to one strategy the entire term. Assuming the advisor has a strong understanding of market behavior along with how to employ certain indexing strategies, the client could enjoy much higher returns through index strategy implementation5.
Figure 4.0 examines that same 10 year period with different rates for the APP, MPP and MoAVG. With the rates having been arbitrarily changed, the annualized results are naturally different than Figure 3.0, but serve to help illustrate the same point. Rates change, but for the contract term, the strategies are what ultimately create the returns. When the client has multiple strategies in their FIA, they are better prepared for ever changing market conditions. When the client has an adviser that understands when
and how to use these strategies, the client is in the best position of all.

Figure 4.0

Figure 4.0 illustrates a 10 year period, February 28, 2001 through February 28, 2011, using three different crediting strategies indexed to the S&P500. The illustrated strategies are the annual point–to‐point, monthly point‐to‐point, and monthly average with participation rate and a 1.50 percent spread. The highlighted numbers exhibit the best performing strategy for its respective year.

Again, you will notice the same concept in Figure 5.0, which uses different rates in an alternative time frame in order to illustrate varying market climates with the same index strategies discussed in Figures 3.0 and 4.0. Figure 5.0 assists in making the argument that no one indexing strategy ultimately performs best in every market climate. In addition, Figure 5.0 assists in the claim that a variety in index strategies within a FIA, regardless of where rates may be at the time, is the preferred method in recommending
FIA products5. Therefore, ideally, advisers should avoid locking themselves into one indexed strategy for the entire term.

Figure 5.0v

Figure 5.0 illustrates a 10 year period, February 28, 1997 through February 28, 2007, using three different crediting strategies indexed to the S&P500. The illustrated strategies are the annual point–to‐point, monthly point‐to‐point, and monthly average with participation rate and a 1.50 percent spread. The highlighted numbers exhibit the best performing strategy for its respective year.
As the figures illustrate, with various and constant rate changes, a client will most likely always be prepared to pull the most yield out of their investment in their FIAs, regardless of market fluctuations, if their FIA contains a varying index strategy structure. It should go without saying that because world markets are in constant flux, whether it be volatility, growth, or decline, a client’s investment vehicle should be structured so that it can progress in any market condition. Fortunately, many FIAs are built
for exactly that, you just need to make sure you are recommending them.

FIA comparative analysis

Fixed indexed annuities are becoming more and more popular every year. This is the result of a large paradigm shift occurring as investor confidence flees the equities and bond markets and seeks refuge under the safe money umbrella.

With a multitude of FIAs available, it is more important now than ever that advisers recommend the best product to the client, however, this is an increasingly difficult task as current products are constantly changing and new products are constantly introduced to the market place. Therefore, as an adviser, do not fall into the lull that many advisers do and recommend the same product to every client. Take the time to review your products, ask questions, consult with your marketing organization, or call the marketing representatives of the carrier. To state it again, the FIA industry is very competitive, and will be so as long as carriers are looking to either grow or maintain their market share.

So as clients are recovering from the portfolio devastation of the last few years and are seeking safer alternatives to the classic equities and bond portfolios, advisors need to be searching for the most efficient way to satisfy the growing class of risk‐adverse clients on their way to retirement.

1 This rule does not serve as the preeminent solution but more as a rule of thumb. It is understood that there are exceptions to most rules and client situations all present unique circumstances.

2 This assertion rings true in recessionary times because interest rates across the board tend to fall towards historic lows, which naturally inhibit growth in fixed and indexed products. Clients and advisers naturally desire to maximize gains every year, and when rates and caps fall, the highest rates and caps are often sought after.

3 This statement is only valid when made in relation to indexed products. This excludes any fixed interest rate products.

4 This is not to make a blanket statement that FIAs with more strategies are the best FIAs. I am advocating that, generally speaking, when you have more index strategies, the client has better opportunity for growth. Before ultimately determining this to be true for any given FIA, a review of the strategies offered is of the most importance.

5 This assertion does not dismiss the importance of advisers understanding the rate histories of the carriers they
represent.